The recovery in the eurozone continues to gather momentum, with economic data on the Continent seemingly improving on a monthly basis. Despite the robust recovery, Europe is still often maligned by investors, with the region’s stocks trading at an unusually large cyclically-adjusted P/E discount to US counterparts.
We continue to find a number of compelling investment opportunities in Europe. For example, here are the four additions to our SWMC European Fund this year:
Our most recently addition is French semiconductor materials company Soitec. The company employs proprietary Smart Cut technology for the manufacture of silicon on insulator (SOI) chips, which boast greater reliability and energy efficiency than traditional silicon alternatives.
Soitec’s growth rate of the group is beginning to accelerate rapidly as foundries increasingly employ Soitec’s more mass market FD-SOI technology for the internet of things and the automotive industry. FD-SOI has the advantage being cheaper and easier to work with than competing FinFET technology, which is more suitable for more complex projects. For example, FD-SOI was used in the Amazfit watch enabling 2.5x the battery life compared with other similar watches.
At the same time, Soitec’s operating profitability should rise from some 9% currently to 16%, or more, in the futureas existing manufacturing capacity is filled. While it appears expensive, trading on 52x prospective earnings, the multiple could fall to under 10x by 2020 as the market for the internet of things and automotive technology takes off.
Yara is the world’s largest fertiliser producer and is also developing a higher value-added crop nutrition business. Recent history has been challenging for Yara. Following the 2011 to 2014 farming boom years, grain prices fell sharply, significantly stressing the industry. At the same time, Yara and other fertiliser producers had to cope with extra capacity built up in the ‘good times’. In particular, western manufacturers faced a flood of cheap exports coming out of China.
However, the outlook is now beginning to look more positive. Chinese exports have fallen by a dramatic 61% since the start of this year. Chinese manufacturers are facing more stringent environmental rules and were heavily – and unsustainably – loss-making in 2016. At the same time, Yara’s relative competitive position has improved on the back of lower gas feedstock prices.
The period of difficult market conditions prompted Yara to tackle costs aggressively. Management now has plans further to reduce the cost base by an additional $500m – which is 50% of 2016 EBIT. The team is also hoping to add a further $600m to sales by expanding premium products, most notably in Brazil. Currently trading on 1.2x book value, it appears enticingly valued for a company that generated 15% ROCE over a full cycle in the past.
Nokian is a successful producer of car, truck and heavy machinery tyres for the winter and off-road markets. The group’s new products are developed in Finland and manufactured in highly efficient plants located both in Russia and Finland.
Nokian Tyres has an exceptional record of capital generation, reflected by a share price that has risen 10 times since the year 2000. Even last year, despite a sharp fall in sales in Russia, the business still generated a 24% return on capital and a 22% operating margin. Nokian’s finances are also strong – with an equity ratio of 71% at year-end, and held net cash of €210m.
Our investment comes at a time when Russian sales are starting to recover significantly. Furthermore, there is enormous scope for expanding sales in the EU, beyond the home Nordic territories. Nokian’s market share in the EU-ex Nordics is barely 1%, but sales here grew by an impressive 14% in 2016. It has also successfully entered the summer tyre market. While the base is still small, summer tyre sales grew by 45% in the last quarter of 2016. Nokian offers good value at 15x 2018 earnings and a yield of 4.3%.
The first addition to our portfolio in 2017 was world-leading Danish container shipping and energy group Maersk. In the wake of the dramatic decline in shipping rates, the group has embarked upon a bold strategic plan in order to refocus the business on container shipping and improve profitability.
Management has firstly decided to separate out the energy business, by either a sale or flotation. Capital expenditure will also be more tightly controlled across the company. This is most notable in the terminal division, where no further expansion is expected. Finally, management aims to increase the return on invested capital by 2% over the cycle, through increased terminal utilisation, selling more inland services and cross-selling.
After two years of declining freight rates, the outlook for the container market appears to be improving as well. The recent collapse of Hanjin, which removed 3% of supply from the market, may well have marked the turning point. Trading on a trough valuation of 0.8x EV over invested capital, Maersk shares appear attractively valued, especially considering the depth of the restructuring programme and the apparent improvement in the container shipping market.
Stuart Mitchell is CIO of S. W. Mitchell Capital